A Price Ceiling Has Unintended Consequences

The Minimum Wage Debate

Sep 4, 2010 • Businesses, Demand, Supply, and Markets, Economic Debates, Economic History, Labor, Macroeconomic Measurement • 182 Views    4 Comments

Should we like a higher minimum wage? With the release of 9.6% as the August, 2010 unemployment number, I thought about the minimum wage debate. The teenage unemployment rate is 26.3%.

In 2007, Congress increased a $5.15 minimum wage in three stages. On July 24, 2009, the final 11% raise, from $6.55 to $7.25 was implemented in the 31 states with a lower minimum wage.

If you owned a fast food restaurant and were told that you had to pay workers a higher minimum wage of $7.25 an hour, what would you do? Give everyone raises and pay the increased hourly rate to new hires?  Only give raises to current employees but decide not to do the hiring it had planned? Terminate certain positions? Other alternatives? You might want to look at a good discussion here.

The Economic Lesson

Originating in Australia and New Zealand during the 1890s, minimum wage legislation was first passed federally (it had existed in individual states) in the U.S. through the 1938 Fair Labor Standards Act. Believing that employers were paying “substandard wages” and perpetuating sweatshops, Congress sought to ensure a “fair wage”. Their rationale was the need to tilt the balance of power toward workers.

Graphically, economists illustrate the minimum wage through a “floor”. Please imagine for a moment a supply and demand graph. Price is the y-axis and quantity is the x-axis. Thinking of wages, the supply curve represents labor and the demand curve is the business side of the market. The point at which demand and supply meet, called equilibrium, is the wage (the price of labor) determined by the market.

Government, however, can say that it believes the market determined wage is too low. It then mandates a higher wage that can be depicted as a horizontal line placed above equilibrium. Economists call this horizontal line a “floor” because it stops wages from moving lower to their natural market price. 

And therein lies the dilemma. A higher wage or more jobs? Floors create surpluses. At the new, higher wage, the number of jobs laborers want is more than the number of jobs businesses are willing and able to offer. So, we have a higher wage but fewer jobs. Perhaps 26.3% fewer jobs for teenagers and other unskilled workers?

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